You are here

Equity, justice, and efficiency

24 December, 2015 - 10:36

Our discussion of environmental challenges in the modern era illustrates starkly the tradeoffs that we face inter-generationally: disregarding the impacts of today’s behaviour can impact future generations. Clearly there is a question here of equity.

Economists use several separate notions of equity in formulating policy: horizontal equity, vertical equity, and inter-generational equity. Horizontal equity dictates, for example, that people who have the same income should pay the same tax, while the principle of vertical equity dictates that people with more income should pay more tax, and perhaps a higher rate of tax. Intergenerational equity requires that the interests of different cohorts of individuals—both those alive today and those not yet born—should be balanced by ethical principles.

\mid Horizontal equity is the equal treatment of similar individuals.

\mid Vertical equity is the different treatment of different people in order to reduce the consequences of these innate differences.

\mid Intergenerational equity requires a balancing of the interests and well-being of different generations and cohorts.

Horizontal equity rules out discrimination between people whose economic characteristics and performance are similar. Vertical equity is more strongly normative. Most people agree that horizontal equity is a good thing. In contrast, the extent to which resources should be redistributed from the “haves” to the “have-nots” to increase vertical equity is an issue on which it would be difficult to find a high degree of agreement.

People have different innate abilities, different capacities, and different wealth. These differences mean people earn different incomes in a market economy. They also affect the pattern of consumer demand. Brazil, with a very unequal distribution of income and wealth, has a high demand for luxuries such as domestic help. In more egalitarian Denmark, few can afford servants. Different endowments of ability, capital, and wealth thus imply different demand curves and determine different equilibrium prices and quantities. In principle, by varying the distribution of earnings, we could influence the outcomes in many of the economy’s markets.

This is an important observation, because it means that we can have many different efficient outcomes in each of the economy’s markets when considered in isolation. The position of a demand curve in any market may depend upon how incomes and resources are distributed in the economy. Accordingly, when it is proposed that the demand curve represents the “value” placed on a good or service, we should really think of this value as a measure of willingness to pay, given the current distribution of income.

For example, the demand curve for luxury autos would shift downward if a higher tax rate were imposed on those individuals at the top end of the income distribution. Yet the auto market could be efficient with either a low or high set of income taxes. Let us pursue this example further in order to understand more fully that the implementation of a degree of redistribution from rich to poor involves an equity–efficiency trade-off.

Application Box: Equity, ability, luck, and taxes

John Rawls, a Harvard philosopher who died recently, has been one of the most influential proponents of redistribution in modern times. He argued that much of the income difference we observe between individuals arises on account of their inherited abilities, social status, or good fortune. Only secondarily, he proposes, are income differences due to similar individuals making different work choices.

If this view is accurate, he challenges us to think today of a set of societal rules we would adopt, not knowing our economic status or ability in a world that would begin tomorrow! He proposes that, in such an experiment, we could collectively adopt a set of rules favouring the less fortunate, in particular those at the very bottom of the income heap.